March 10, 2016

WSJ: The Financial Bungler in the Kremlin

Who’s the world’s worst investor in the past 18 months? Look no further than Russian President Vladimir Putin. He has been long and wrong with a giant energy portfolio and controls too many commodities. Plus he has tons of debt and a currency bet that has gone so bad his nickname should be Vlad the Impaler. And he may take down the Russian Federation with him.

Oil has cratered so badly that it needed a modest bump in the past couple of weeks to get its nose above $38 a barrel, still way down from $50 a year ago and $105 in June 2014. A slip back into the 20s is entirely possible. Energy is almost a quarter of Russian GDP. The Russian state owns three-quarters of the oil company Rosneft (40% of Russian oil output) and just over half of natural-gas producer Gazprom. The company is now worth under $50 billion, about half its value 18 months ago and down almost 85% since June 2008, when Gazprom was worth $344 billion, according to the Financial Times. By contrast, Exxon is down 24% over that period.

The Russian ruble has been falling like a sack of potatoes. It is 71 to the dollar, down from 34 in mid-2014—doubling the price of imports. When the ruble lost value in late 2014, the government intervened in currency markets, selling dollars from their reserves and raising interest rates to 17%. The ruble rose to 50 to the dollar, but after blowing through over $80 billion in foreign currency to stabilize its own, the government stopped protecting the ruble. This led to the current free fall. Interest rates are now 11%, but according to the Central Bank of Russia, inflation last quarter was 12.9%.

There is some good or at least not-bad news. According to the Central Bank, as of January 2016, Russia’s external debt, money owed to creditors outside of Russia, was $515 billion. Down from $733 billion in mid-2014, it is moving in the right direction. And perhaps only 20% to 25% of that debt is current, meaning payable in 2016. Government foreign reserves as of January 2016 were $371 billion, with $51 billion in gold. They’ve been chewing through these reserves over the past two years, but if they lay off currency trades, on paper it looks like they’ll survive.

But Central Bank data also show that 83% of Russian debt is denominated in dollars or euros. Every day the ruble drops in value, the debt owed goes up. This hurt Russia and Asia in the late 1990s, but the former didn’t learn.

In the first half of 2016, oil giant Rosneft owes a debt payment of $14 billion to a series of Western banks, including J.P. Morgan, Citi and Bank of America. Rosneft may have enough cash to pay because of oil clients’ forward payments, but the company’s profits don’t appear high enough to make future debt payments. Mr. Putin’s game of chicken in Kiev brought financial sanctions from the West—last week Goldman Sachs pulled out as the underwriter of a Russian debt deal—and not even the Chinese appear likely to finance a debt workaround for Russian companies.

It gets uglier. In 2015 Russia ran a financial deficit of $40 billion, about 3% of GDP. The Russian economy is also in a serious recession. Though the International Monetary Fund now predicts a 1% drop in GDP in 2016, it could be closer to 5%. Regional governments with more than $100 billion in internal debt are in worse shape. The Higher School of Economics in Moscow estimates that 20 of 83 regions may already be in technical default.

At the same time, Russia’s military spending keeps creeping up. Last week, Moody’s said it may downgrade Russian debt. And internal unrest is spreading. In December, Russian truckers, who should be heartened by cheap oil, staged a protest in Moscow against increased highway fees charged by a government scrounging for money. Wait for food protests to start.

Prime Minister Dmitry Medvedev said recently that “dramatic movement of the oil market is creating rather serious risks for carrying out the budget.” The latest Russian budget assumes $50 oil. At $30 oil, this year’s government deficit could top $100 billion.

Those $371 billion in reserves will disappear fast in a static world, and even faster if oil dips closer to $20 and the ruble hits 100 to the dollar. A rising dollar would drive this. Maybe that’s why Mr. Putin is selling everything not tied down, calling it “privatization.” Finance Minister Anton Siluanov recently announced that the government was looking to sell 19.5% of Rosneft. Aeroflot may be next. Buyers will be able to hold out for fire-sale prices. You can thank sanctions, the U.S. fracking boom and a strong dollar for weakening Mr. Putin’s rule.

Within a single century, Russia has been the host to three failed political systems: the czar’s monarchy, communism and now a kleptocracy. With luck, the Russian people may finally get to choose the system for the next 100 years.